Default correlation impact on the loan portfolio credit risk measurement for the "green" finance as an example

No wps121, Bank of Russia Working Paper Series from Bank of Russia

Abstract: Default correlation parameter has a material impact on the loan portfolio credit risk. Moreover, the impact is more complex than that of the default probability itself. Current study shows that the rise in default correlation can simultaneously lead to multi-directional changes in different types of risk-measures or focus on a single risk measure, but at different confidence levels. The cause for such dual impact lies in the often neglected rising impact of the default rate (DR) distribution bimodality. In general, we evidence that rise in default correlation produces a multiplicative effect of the probability of default (PD): risk measure declines for low PDs and rises for high PDs, but changes are non-proportionate for the same changes in default correlation. Similar effects, in particular, may arise when augmenting the proportion of "green" lending. Moreover, when such a trend is associated with the decline in PD for the "green" sector and PD rise for the "brown" one, there is an overall reduction in the loan portfolio credit risk in the long-run. However, it is witnessed only after its rise in the mid-term. The paper is accompanied with the relevant codes. They enables the interested parties to replicate the findings, as well as to derive credit risk parameters for any given DR time series and model a DR distribution for any set of distribution mixture parameters.

Keywords: default correlation, bimodal distribution, default rate; cliff effect, mixture of distribution (search for similar items in EconPapers)
JEL-codes: C34 C67 E52 H23 O44 (search for similar items in EconPapers)
Pages: 59 pages
Date: 2023-12
New Economics Papers: this item is included in nep-ban and nep-rmg
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